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Monday, April 23, 2012

401(k) Fee Case Decided on its Merits -- Plaintiffs Prevail !!

We knew that it was coming. Sooner or later, a 401(k) excessive fee case was going to be decided by a court of law on its merits rather than being settled before a court could rule. If you like, you can download a pdf of the decision in Tussey v ABB, Inc. here. This case may not be over, though. The ruling was made in the District Court for the Western Division of Missouri, Central Division. Missouri lies in the 8th Circuit, not one of the ones bemoaned by the legal profession for its entirely odd decisions.

So, what happened?

ABB, a company with significant US operations, but a Swiss parent, has maintained two 401(k) plans (union and non-union) in the United States. ABB and its 401(k) plans were fairly long-term recordkeeping clients of Fidelity. However, Fidelity was not only the recordkeeper, but also a 3(21) investment advisor. The plans offered primarily Fidelity investment options. Over time, Fidelity became not only the TPA for the 401(k) plans, but also for ABB's pension plan, its health care plans and its payroll services.

The judge in the case was Nanette Laughrey, a 1995 Clinton appointee. The Wikipedia article on her describes her as "a stern judge." Judge :Laughrey's decision is thick. It reads a full 81 pages and is not complimentary of the actions taken by defendants. In fact, in my reading, the only thing that I could find for which she did not berate defendants was that they did, in fact, have an investment policy statement (IPS). Whether this worked in their favor or against them is not clear.

On to the case itself. The Court gave significant weight to the testimony of an expert witness on fee issues. The expert analyzed the fees that the plans paid over a 6-year period. On average, according to testimony, those fees ranged from approximately $65 per participant to $180 per participant per year. The same expert found that a reasonable fee would have been in the range of $44 to $70. Paramount in the expert's comparison was that of the ABB plans to the Texa$aver Plan, a non-ERISA governmental plan. At the beginning of 2000, ABB's 401(k) plan assets were approximately $1.4 billion while the Texa$aver Plan had somewhere north of $1 billion.

It gets worse. ABB did the right thing, but made the right thing bad by ignoring its own process. In 2005, whether it was a serious fee check or merely to check a box on its IPS, ABB hired Mercer to review its fees. Mercer found three problems: 1) the fees that ABB was paying to Fidelity were excessive, 2) the fees paid by the plan were subsidizing other non-plan services that Fidelity was providing to ABB, and 3) when plan assets increased, ABB paid higher fees under a basis point arrangement, but when plan assets decreased, Fidelity charged additional hard dollars to make up the difference; in other words, Fidelity was collecting increased dollars for the same amount of services.

The words of the Court could be particularly troubling to ABB. While the opinion is relatively scathing from beginning to end, here are some of the most troubling issues cited:

The IPS stated, "[a]t all times ... rebates will be used to offset or reduce [emphasis added] the cost of providing administrative services to plan participants." In failing to due this, ABB violated its own IPS and breached its fiduciary duty.

In some cases, the plans used Fidelity share classes that were not the least expensive available to them. This was expressly in violation of language in the IPS saying that they would choose the share class with the lowest expenses. This, the Court found, violated their duty of fiduciary prudence.

While the Court did not find revenue sharing, per se, to be problematic, it noted that ABB allowed Fidelity to take revenue sharing as a means of covering recordkeeping costs, but that it did not offset or reduce administrative costs, in direct violation of ABB's IPS.

In 2000, ABB removed the Vanguard Wellington Fund (a balanced fund) for poor performance. It replaced the Wellington Fund with Fidelity Freedom Funds (target date funds or TDFs). Again, their own IPS worked against them. It required a review of a 3-5 year performance (if that period existed) and if there were 5 years of underperformance, a fund went on the Watch List. After 6 more months, it could be removed. The Wellington Fund had a 70-year track record. That track record was exceptional. Additionally, over the 3-5 year monitoring period, it beat its Morningstar benchmark by more than 400 basis points.

To this, the Court noted "suspicions" about the "conflicted relationship" between ABB and Fidelity. The Court supposed that the relationship "infected far more than the specific instances" that plaintiffs had raised as fiduciary breaches.

The Court found the following damages:

$13.4 million in lost fees for failure to properly monitor recordkeeping costs

$21.8 million in the mapping from the Wellington Fund to the Fidelity Freedom Funds

$1.7 million against Fidelity for improperly retaining the float on plan benefits

Remember, the 408(b)(2) fee disclosure regulations will finally take force this summer. Data such as this will be much more transparent. Plaintiffs bar will be monitoring.

If I were an ERISA plan sponsor that was paying fees from an ERISA trust, I would do all of the following post haste:

Ensure that an Investment Policy Statement is in place

Ensure that the IPS is being followed

Consider whether any fees that are asset-based rather than service-based satisfy the fiduciary duty of prudence

Confirm that the IPS policies and procedures for monitoring of funds and replacing funds are being followed

Disclaimer

The opinions expressed in this blog are not those of anyone but the author of the particular post or comment. Nothing in it is to be construed as the opinion of any employer unless specifically disclosed as such.

The express intent of this blog is to provide no investment advice of any type. While asset allocation and theory may be discussed in a research or academic context, no advice as to specific investments or strategies is intended or permitted.